Abstract:
Many attempts have been made to figure out the real reasons for inflation in every
economy. Inflation is considered to be monetary phenomenon in long run. Monetary
policy tools such as interest rate and money supply are considered to be one of major
determinants. In this paper we will study the relationship of Monetary Policy with
Inflation with special focus on Pakistan. The study will analyze the State Bank of
Pakistan’s monetary policy and tools it is using to control the inflation. The literature
review describes the view about inflation and economic policy from different economists
around the world and from Pakistan. The methodology of research consists of regression
and correlation models where we test the relationship of inflation specifically with
monetary components and then with addition of non-monetary components i.e wheat
price, fuel price and exchange rate. This Two-model approach is to figure out the real
effect of monetary components on inflation in Pakistan. In analysis part, the study tests
the relationship of money supply and interest rate with inflation, based on past ten years
data to figure out the trends and relationship of different variables with inflation.
Whereas, different regression models and different correlation tests show variance in
results, the highlight of the outcomes from this study is the failure of monetary policy to
control the inflation, whether for absolute relationship of inflation with monetary policy
or relative relationship of inflation with other determinants. Finally we conclude the
study with recommendations to improve the monetary policy in order to control the
inflation.
